Speech by SEC Chairman:
Remarks at Northwestern University School of Law
Chairman Christopher Cox
U.S. Securities and Exchange Commission
January 22, 2007
Thank you, David [Ruder]. As you all know, Professor Ruder—Dean Ruder—was himself an outstanding Chairman of the Securities and Exchange Commission, and his contributions to the strength of our capital markets are still being felt today. And he remains a national leader in ensuring the integrity of securities trading in the United States and around the world, not least of all in the area of corporate governance. Thank you, David, for all that you have contributed to the health of America’s economy and to the security of our national savings.
I want to salute Bill Brodsky, a fellow regulator, who as you know is the President and Chief Executive Officer of the Chicago Board Options Exchange, and his wife Joan. It is, of course, the generosity of the Brodsky Family Northwestern JD-MBA Fund that has made this event possible. And when the Brodskys say family, they mean family. Bill's father was a 60-year veteran of Wall Street. And his three sons all have JD-MBAs, and every one of them is in the investment business. No wonder his family set up the JD-MBA fund—it was a big upfront cost, but they hope to make it up on volume.
Dean Van Zandt of the Law School and Dean Jain of the Business School—thank you both for being here, and for the investment of your own time, wisdom, and experience that you're making in the development of America's future financial leaders.
And last, but not least, I have to acknowledge ’da Bears. And I particularly feel compelled to acknowledge Rex Grossman, since so many people find it easy not to. He's the second most productive quarterback in the history of the Bears. And yet, like Rodney Dangerfield, he gets no respect. It may be that Rex Grossman, with his blasé fans and his League Championship, is a metaphor for Chicago's financial markets. After all, the exchanges here are the second most productive in America, behind New York City, which humbly calls itself the financial capital of the world. But there's nothing second city about Chicago when it comes to markets and investments. This is, as a matter of fact, the first city in the world when it comes to commodities trading and derivatives.
Like Atlas carrying the world on his shoulders, Chicago carries the world's commodities derivatives trading on its famously "Broad Shoulders"—and in the realm of futures and options, no city or market center can claim greater credit for its role in capital formation and value creation.
And just as Chicago has won worldwide acclaim for its four major exchanges, Northwestern has earned praise for your world class academic and research programs. This is an environment that nurtures learning—and it even feels that way, standing here in Lincoln Hall. I'm told that this imposing structure was built all the way back in the 1860s, and made to look like the House of Lords. That adds a whole new meaning to “peer pressure” in law school.
Although it's been a few years since I was a JD-MBA candidate, I remember well the chaos of conflicting schedules and the competing demands of both business school and law school that come at you simultaneously. So for the students here tonight, I know what you're going through.
That's particularly so because a half dozen years after I graduated from Harvard's JD-MBA program, I joined the faculty there. I taught a second year course in the MBA program called Tax Factors in Business Decisions. And you know, it really is true that teachers can learn a great deal from their students. In my case there’s no better example of this than with the first final exam I gave. That experience helped me see the JD-MBA program through a slightly different lens.
Remember, this course was called Tax Factors in Business Decisions. It was a survey course in individual income tax, corporate income tax, and estate and gift tax. And the final exam was 50% of the total grade. I hope my students learned something from me, but I can tell you, I learned a lot from them. I’ll never forget grading those final exams. The final was four hours long—two cases, each nefariously constructed to contain every known tax problem. And so the students filled up a half dozen blue books with their answers. It was a bear to grade.
But there was one student who used only one blue book. I can’t tell you how excited I was to open the cover and review this model of brevity and concision. And when I opened his test book I discovered he’d only used one page for his answer to both problems. Here’s what he wrote: “Dear Prof. Cox: What I have learned in your course is that federal income tax is extraordinarily complicated, and when I go into business, I’ll be sure to hire someone who knows what he’s doing in this area.”
Obviously, that fellow had a lot more aptitude for improv than for finance. So if he ever went to work in Chicago, it was much more likely with Second City than Citi.
In the few moments we have together this evening, I’d like to share just a few thoughts with the students here, about what accounts for America's superlative economic performance when compared to other nations, and about the role that you'll soon play as leaders in our economy.
Almost any analysis of what makes our nation so successful begins with recognition of the mainstays of America's free enterprise economy: First, the rule of law – and the absence of corruption, bribery, and other forms of coercion by government and powerful economic actors that the rule of law ensures. Second, a climate of entrepreneurship that encourages men and women to take risks. And finally, a large, efficient capital market to finance it all.
The SEC has important responsibilities in each of these areas. Our law enforcement duties are an essential element of maintaining the rule of law in our nation's economy. Our powers to prosecute fraud and unfair dealing are guarantors against corruption and bribery. Our responsibility to exercise prudence and discretion in the use of those powers is key to maintaining a regulatory climate that is friendly to entrepreneurship and risk taking. And our regulation of markets, including those here in Chicago, is aimed at upholding their integrity and efficiency.
When distilled to its essence, this threefold mission of the SEC—to protect investors; to maintain fair, orderly, and efficient markets; and to facilitate capital formation—is really all about making America more productive. I am absolutely convinced that our inspection and enforcement activities deter fraud; that our regulation of the exchanges maintains orderly and efficient markets; and that our disclosure regime helps investors make sound decisions. These are all essential aspects of well-functioning capital markets.
But before you conclude that these are mere truisms, or nostrums on good governance with which no one could disagree, let me promise you that if after you graduate from this esteemed institution, you someday make it to the executive suite, the SEC rules that are just now going into effect for the first time this year will require you to disclose everything you make, right down to the last penny. As the leader of one of America's public companies, you'll get to experience in a very intimate way what full disclosure really means.
Since the day I began as Chairman of the SEC, I have been focused on translating the legal gobbledygook that investors have to plow through in annual reports and proxy statements into plain English. That's because clearly written disclosure is absolutely necessary for investors to gain the benefits of market information. And when it comes to disclosure documents intended for investors, nothing is more complicated than the description of executive compensation. So we aim to simplify it, and make it more meaningful.
A proxy statement today may well contain all the required information, and yet still not tell anybody much of anything. Is it really disclosure if the investor has to sort it out and piece it together? Investors and their directors have a right to the information: Complete. Clear. Comprehensible.
It's quite simple, really. If someone orders a steak, you don't give them a cow and a meat cleaver. Investors should get all the information they need—and they should get it in a form they can use.
In the summer of 2005, when I took over the duties of Chairman, there was a rising chorus of criticism and complaints about CEO pay. Like the weather in Chicago, everyone was talking about it. And just as with the weather, no one was doing anything about it. So we determined to tackle the issue head on – and now, those efforts are coming to fruition.
Too often, compensation disclosure has been written with the objective of saying as little as possible while avoiding legal liability, instead of truly informing investors. And yet executive compensation truly matters—not only for the reason because if the moral hazards and conflicts of interest are left unchecked, executives will be paid too much, but also because it can play a valuable role in disciplining management across the board, and in protecting the entire range of shareholder interests.
By restraining executives from self-indulgent behavior—and using salary, bonuses, options, long term benefits, and other financial incentives in very purposeful ways—compensation committees acting on behalf of the shareholders can increase management’s incentives to improve corporate performance.
So our purpose in this very aggressive new executive compensation rule is very straightforward: It is to protect and advance the interests of shareholders.
When you get a proxy statement in the mail this year, it will look different. For the first time, all of the information will be in one place. The most dramatic change is that there will be one number—a single figure—that reflects the total compensation earned by the executive last year. It will attempt to capture not just salary, which is easy, but also non-cash perquisites, retirement benefits, and contingent compensation such as options that might or might not vest in the future. In making the judgments concerning precisely how best to do this, we were careful to strive above all for accuracy.
Some complained that by lowering the threshold for what would be counted as a perk from $50,000 to $10,000, we were requiring executives to report too much detail. Others complained that by not adding to last year’s pay the estimated value of all options that might vest in the future, we did not show enough in our one number. But in every case we have settled the disagreements by requiring the reporting of 100% of all present and future compensation in real time—this year, not later. With options, for example, we show 100% of the grants made in the last year, itemized by grant date and exercise price. And in a table right next to it, we show the portion of those grants properly attributable to last year under generally accepted accounting principles.
Just as revolutionary is that for the first time the proxy statement will include a principles-based narrative explaining why the compensation program is structured the way it is. By detailing the objectives of its compensation program, a company can let its investors in on just how the particular levels and forms of executive compensation were arrived at. This is what good disclosure is all about.
Of course, it is also vital that investors receive the enhanced information they need in a form they can easily access and understand. A shareholder should not have to be a compensation expert, or a JD-MBA from Northwestern, to understand executive compensation disclosure in a proxy statement. So the new rules require that everything be laid out in plain English. That means the complex legalistic jargon and the generic “boilerplate” language you're learning here in law school is verboten.
What the SEC has in mind is no less than transforming the landscape of public disclosure for the benefit of investors. By giving investors more, and importantly more usable, information we can enable increased participation by better-informed shareholders.
As you may know, at the same time that we are making the disclosure you get more thorough and easier to read, we're also working to make it interactive, so you can download it from the Web and compare it with other information from other companies. By going online, you won't just be reading a paper document in electronic form—now you will be able to search a proxy statement for the items you want, and follow links to other, more detailed information.
With more than 75% of Americans having access to the Internet—and spending an average of 25% of their waking hours online—it's high time to bring this revolutionary technology to the world of shareholder democracy. When progress is about to overtake you, you either ride the wave or get wiped out—or at least that's how it is in Southern California.
I hope this brief insight into just one aspect of the work we're doing at the SEC has given you a feel for our mission, and our enthusiasm for it. In the coming months, our new executive compensation initiative is going to give investors far more in the way of disclosure about executive pay than has ever existed before—and far more than is available anywhere else in the world. I know it will be of value to you as investors.
And for the students here who hope someday to run companies yourselves, I hope that if one day you make big news with your bonus, it will be because of the success you've earned by treating your investors right.
The hopes of our nation and our economy really do depend on you. So take a leaf from the Brodsky family album, and keep Northwestern, the great markets of Chicago, and the United States of America—in that order—in your hearts. Thank you for inviting me, and best wishes for your future careers.