Speech by SEC Commissioner:
Remarks Before the ABA Committee On Federal Regulation Of Securities
Commissioner Annette L. Nazareth
U.S. Securities and Exchange Commission
December 1, 2006
I am delighted to be here today. I would especially like to thank Keith Higgins for inviting me to speak and for his work as Chair of the ABA's Committee on Federal Regulation of Securities. Today, I will focus on how I believe the internet and technology can assist the Commission in fulfilling our mission more efficiently and effectively than in the past and how Commission rules can encourage their greater use in communicating with investors and the markets. I will also touch on issues relating to the competitiveness of U.S. markets and ways in which the Commission is seeking to achieve greater regulatory efficiency. Before I begin, I must remind you that my remarks represent my own views and not necessarily those of the Commission, my fellow Commissioners, or members of the staff.1
Technology and powerful computer circuitry have long been driving forces in our markets, allowing financial innovation and competition to flourish, particularly by market professionals. However, the use of technology in the realm of communication with shareholders has been slower to develop, and with good reason. Unlike exchanges and Wall Street firms, shareholders, particularly some individuals, may have been slower to fully embrace the internet, making electronic communication more difficult. Now, with internet access available in 80% of all homes, the Commission is fostering greater use of technology in shareholder communications, registered offerings, and corporate disclosures.
Recently, the Commission has adopted initiatives and proposed new rules that will enhance shareholder communication and ease the burdens of communication on issuers, while still accommodating those shareholders who prefer to receive communications in a more traditional format. One year ago, the Commission initiated two changes affecting investor communications: we adopted the Securities Offering Reform rules and we proposed rules for the electronic delivery of proxy materials. We also made EDGAR, our online database of issuer filings, text searchable, and began an initiative to encourage issuers to file their reports in eXtensible Business Reporting Language, or XBRL format.
Much has developed since the Commission's first interpretations in 1995 of the role of electronic communications in dealing with investors, shareholders, and securities offerings. There has been an expansive use of corporate Web sites, e-mail, and push technology (such as RSS), among other technological developments, in getting information out to the market. The Commission has an integral role to play in ensuring that its rules encourage and, in some cases, require the use of new technologies to inform shareholders, investors, and the markets.
Technological advances and the Commission's rules provide opportunities to market participants to better inform investors and the market about important corporate information and developments. The Commission's Securities Offering Reform rules provide an excellent example of how Commission rules, coupled with technological developments and increased use of electronic communications, can foster increased information flow to investors and markets and improved capital access by companies.
Today is the one-year anniversary of the effective date of the Securities Offering Reform rules. I am happy to report that the rules have been extraordinarily successful, particularly in allowing the largest issuers - well-known seasoned issuers - easier access to capital without unnecessary regulatory impediments. Many of the rules' provisions have allowed issuers expanded use of technology in their offerings - to the benefit of investors and offering participants alike.
The loosened communications rules that allow most companies the use of free writing prospectuses in registered capital raising - communications outside the traditional prospectus -have provided companies a tool for quicker, easier communications with investors and enabled them to avoid unnecessary delays in their offerings. Since December 1, 2005, over 5,700 free writing prospectuses have been filed with the Commission, many of them term sheets - and this number only accounts for issuer free writing prospectuses. I imagine that underwriter free writing prospectuses are being used as well.
The rules have encouraged greater use of electronic road shows in offerings without many of the constraints that had existed historically. I have been happy to see offering participants make electronic road shows available in initial public offerings to both retail and institutional investors. Companies are even beginning to make electronic road shows available to retail investors in follow-on offerings. I understand there is actually a Web site dedicated to posting these electronic road shows. I find these developments very encouraging as it furthers the goal of making more information available to retail investors.
Another important aspect of Securities Offering Reform was that "access equals delivery" to satisfy final prospectus delivery obligations. I assume that offering participants are relying on the access equals delivery provisions with regard to final prospectuses. The Commission had estimated that adoption of the access equals delivery provision would provide cost savings to issuers and other offering participants of about $100 million. These savings should help the capital formation process by reducing a significant offering cost.
The Securities Offering Reform rules have provided companies the necessary flexibility and encouragement to use technology to disseminate important corporate developments and offering information. I understand that companies have begun to take advantage of the revised communications rules, providing investors with more timely detailed written information that allows them to understand better the terms of the securities they are buying.
Most of you here today are well-versed in the particulars of the Securities Offering Reform rules and the tools they provide offering participants in communicating with investors. I encourage all of you to use the flexibility in the rules to enhance further the content and type of electronic communications that issuers and other offering participants use in selling securities. The Commission has provided you the tools and encouragement. Allow your clients to be creative - both the marketplace and investors will benefit. Robust issuer information leads to robust markets and improved pricing accuracy.
Electronic proxy delivery may be the next step in the Commission's use of technology to ease the burdens and costs of compliance on issuers. The Commission proposed rules for electronic proxy delivery, or "e-proxy," last year, and is scheduled to consider adopting final rules in the near future. The amendments as proposed would permit a "notice and access" method of delivery, in which a company could mail a paper notice to shareholders directing them to an electronic Web site on which the company had posted its proxy materials. The mailing also would provide the shareholder with a toll-free telephone number and an e-mail address to contact if the shareholder wishes to receive the proxy materials in paper form. If the shareholder requests a paper copy, the company would be obligated to mail it promptly. Otherwise, the company's provision of proxy materials on a Web site would be sufficient. In essence, the rule amendments as proposed would allow companies to shift their default delivery method from paper to the internet, potentially saving the company, and by extension shareholders, significant printing and mailing costs. The staff estimated that from just February to May in 2005, the aggregate cost to public companies for printing and mailing their proxy materials to shareholders exceeded a half billion dollars. Currently, many institutional investors receive their proxy materials electronically. But only about 12% of other beneficial owners vote electronically. Therefore, this proposal will likely have the most significant impact on those retail investors who are the primary recipients of the paper proxy materials.
In addition to the cost-savings, I am hopeful that the use of the internet will enhance the disclosure provided by making it more user-friendly. For example, companies can use hyperlinks to provide quick access to related documents and materials. Shareholders also would benefit because electronic information is more easily searched, allowing shareholders to locate the information that is of the greatest interest to them, and possibly track and compare components of the proxy information across companies.
As in the rules for access to final prospectuses, the Commission proposal contained safeguards that would allow investors without access to the internet to easily request a copy of the proxy materials. While the Commission is still formulating the final form of this rulemaking, it is fair to say that electronic access to information generally is a concept that has wide support among the Commissioners.
The anticipated cost-savings through the electronic delivery of proxy materials may complement other issues currently being considered by the Commission. As you undoubtedly know, the Commission will soon consider a proposal which would set the ground rules for shareholder access to corporate proxy ballots. The Commission last considered this issue in 2003, when it proposed rules that, once certain threshold requirements were met, would allow shareholders to use the issuer's proxy materials to place nominees on the ballot for the company's board of directors.
It is noteworthy that the Commission will consider the proxy access issue close to the time it has been focused on electronic delivery of proxy materials. To the extent there is a concern that allowing proxy access will significantly increase the costs and burdens on issuers of printing and delivering proxy materials, a final e-proxy rule may be one way to mitigate a rise in printing costs due to shareholder proxy access.
Of course, cost is not the only concern surrounding the issue of shareholder proxy access. While I cannot do justice to the complexity of the issues surrounding proxy access during this luncheon, I would like to highlight some of those issues. The Commission's previous consideration of the proxy access issue in 2003 prompted the submission of about 13,000 comment letters. The proponents of the rule seemed to focus on the principle that allowing proxy access would promote accountability in a way that the current avenue for nominating directors did not. The proponents of the rule believed that increased accountability would have a positive effect on corporate governance by promoting better communication between company boards and shareholders, encouraging adoption of best practice corporate governance structures, and making boards more likely to respond to shareholder suggestions of the type expressed through current Rule 14a-8 proposals. Proponents also felt that the accountability could limit conflicts of interest and enhance the quality of the nominating process.
The opponents of the rule cited stability and the ability to attract qualified candidates, as well as costs, when discussing the principles that would be jeopardized if proxy access were accommodated. I recognize these valid concerns and believe that they should be addressed. We might be able to address fears of instability, losing qualified candidates, and spending valuable company resources through proper controls and safeguards on shareholder access. It is incumbent upon all of us to think about proxy access in terms of the principles at issue - the need to balance board accountability and sound corporate governance with the interests that all shareholders have in a healthy, profitable corporation.
I believe that both proponents and opponents of the 2003 proposal for proxy access realized that avenues toward sound corporate governance are in everyone's best interest. It is my hope that we can build on the suggestions and comments from the 2003 proposal, raising the level of dialogue to one of practicality and purpose, designed to address the issue in a principled way.
The application of available technology is one of the elements that should be addressed in the dialogue. Our proposed e-proxy rules could be available for use by intermediaries and shareholders, as well as by issuers. The application of technology in any proposal for shareholder access should build upon the lessons learned and the comments received regarding the Commission's e-proxy proposal.
The Commission is also exploring the use of technology in the area of mutual fund disclosure. In June of this year, the Commission held a roundtable that considered mutual fund disclosure issues, such as providing mutual fund information to investors through increased use of the internet, interactive data, and other electronic means of delivery. The roundtable participants, including representatives from investor groups, the mutual fund industry, analysts, and academia, all seemed to agree that a streamlined mutual fund disclosure document could effectively serve investors' needs if the disclosure document contained key information such as investment objectives and strategies, expenses, risks, and historical returns. The Commission staff is pursuing the idea of a streamlined disclosure document, coupled with greater use of the Internet for more detailed disclosure, and I look forward to considering the staff's recommendations in this area.
Technology has shaped more than just the Commission's rulemakings regarding securities offerings and the delivery of proxy materials. Technology has shaped the Commission's own interactions with investors. In addition to incorporating the use of technology into its rulemakings, the Commission has also focused on technology as a tool to enhance investor protection through more accessible information. Filings have been publicly accessible through EDGAR on the Commission's Web site since 1995. EDGAR has improved steadily over the years, with privatization of certain processes in 1997, and real-time public access to filings available in 2002.
Not many now remember that EDGAR originally stood for "Electronic Data Gathering, Analysis, and Retrieval." The Commission has taken steps recently to focus on the "analysis" part of EDGAR's name, making it a more user-friendly and valuable resource for investors. Through EDGAR, investors can now search the full text of the filings. For example, if an investor is interested in comparing public companies that manufacture blue widgets, then the investor need only search for the words "blue widgets" on EDGAR to produce a list of results.
Once finding all the companies that manufacture blue widgets, investors will soon be able to use interactive data programs to extract numbers and compare the companies' financials, point by point. The Commission's XBRL initiative is progressing quickly. Already, a number of companies have joined the pilot, and several programs are available, some for no cost, which will download the XBRL data from the SEC's Web site and create spreadsheets of comparative data across companies. In September, the Commission committed $54 million for three contracts to allow EDGAR to fully utilize filings made in XBRL format. Among other things, the contracts will modernize EDGAR and maintain the database, which now receives 700,000 filings each year.
In addition to improving investors' access to information, the Commission's XBRL initiative is consistent with the filing format already used by other regulatory agencies. The FDIC, the Comptroller of the Currency, and the Federal Reserve all require banks to make filings in XBRL format. As Treasury Secretary Henry Paulson noted recently, there is a need for consistency among regulators, especially when regulatory goals are similar.
The Commission is actively looking at other ways to improve regulatory efficiencies. Although this goal is important in and of itself, there has been a heightened focus recently on the burdens of regulation and its effect on the competitiveness of American markets, both now and in the future. I agree with Secretary Paulson's recent remark that our markets are not immune to competitive challenges - I, too, believe that the future competitiveness of American markets must be closely examined.
As Secretary Paulson aptly stated last week, "when it comes to regulation, balance is key. . . . The right regulatory balance should marry high standards of integrity and accountability with a strong foundation for innovation, growth, and competitiveness."
The Commission is addressing several issues that may have an impact on the competitiveness of our markets, including Section 404 implementation and regulatory consolidation. Very shortly, we will be addressing the very significant problems experienced with the implementation of Section 404. Although I support the overall reforms achieved by the Sarbanes-Oxley Act, the criticisms of Section 404's implementation were well-deserved. The implementation problems relating to Section 404 must be addressed.
The need for more guidance on how to cost-effectively implement Section 404 is especially acute in the case of certain issuers, including smaller public companies. We and the PCAOB are committed to finding a means of easing the burden on smaller issuers while ensuring the integrity of the internal controls.
The costs of over-auditing have also been apparent, and relief should come in the form of the PCAOB's anticipated amendments to its Auditing Standard No. 2. These amendments are intended to reduce the prescriptive nature of the existing standard and instead focus auditors on areas that pose a higher risk of fraud or material error, allowing them to make their audits of internal controls more efficient and cost-effective. Providing more clarity of purpose to the audits instead of giving auditors a checklist should underscore the principles of requiring an auditor attestation under Section 404. That purpose is to disclose to investors whether internal controls are in fact designed to ensure reliable financial reporting.
Another significant area in which I foresee greater efficiencies on the horizon relates to our two major self-regulatory organizations (SROs). The New York Stock Exchange (NYSE) and the NASD recently announced that they will combine their regulatory areas into a single entity. After a merger, the broker-dealers subject to oversight by both the NYSE and the NASD would be required to comply with one set of self-regulatory rules, and be overseen by one entity, substantially reducing duplication and inconsistencies. I strongly support the merger of these two self-regulators and believe it will further the interests of the investing public as well as the brokerage industry.
Today, despite criticism over certain regulatory inefficiencies, the U.S. capital markets remain the deepest and most liquid markets in the world. At the same time, we have the highest level of investor protection and, I would argue, despite some notable missteps, our markets are distinguished for their fairness and transparency. More than in any other country, our markets have a significant participation of individual investors -investors who must have confidence in our markets. So while we have the responsibility to ensure that the American markets keep their competitive advantage, we cannot sacrifice important investor protections which give individuals the confidence to keep their money in our markets. It is important to balance the burdens of compliance with investor protection. I believe that the Commission will achieve this goal in part through technology - making data as transparent and accessible as possible, and by using technology to reduce costs for issuers through initiatives such as the Securities Offering Reform and e-proxy proposed rules. The reforms relative to Sarbanes-Oxley Section 404, as well as the consolidation of the NYSE and the NASD, promise to create even greater regulatory efficiencies without shortchanging investor protections. It is essential that we keep our eye on the ball if we are to maintain our competitive edge globally.