Speech by SEC Chairman:
Re-Thinking Regulation in the Era of Global Securities Markets
Chairman Christopher Cox
U.S. Securities and Exchange Commission
34th Annual Securities Regulation Institute
January 24, 2007
Good afternoon, and thank you, John [White, SEC Director of the Division of Corporation Finance] for that kind introduction. This proves the rule that you should always strive to be introduced by someone who works for you. Truly, John, those were most generous words, and you are very kind to say them.
So now it is my turn to brag on John. He has been an exceptional leader of the Division, and as you all know he brings with him a wealth of experience and knowledge. It is a tribute to the agency that men and women of this caliber are willing to devote themselves to its mission. And it speaks volumes about the accomplishments of those who have gone before us, some of whom are with us today, including Ed Greene, former Director of the Division of Corporation Finance and General Counsel at the SEC, and David Ruder, who was Chairman of the SEC from 1987 to 1989. Thank you for your leadership and your exceptional public service.
I notice in looking around my table that the SEC is well represented here today with Californians. It's been reported that not since Rod Hills was Chairman have there been so many Californians at the top of the Commission. At our table there is Brian Cartwright, General Counsel, formerly of the Los Angeles office of Latham & Watkins; Conrad Hewitt, Chief Accountant, who was formerly California's top banking regulator; and Mike Halloran, Deputy Chief of Staff and Counselor, who was most recently with Pillsbury Winthrop Shaw Pittman in San Francisco. Thank you to each of you as well, for your willingness to move East and devote yourselves once again to public service.
For my part, I'm thrilled to come home to sunny southern California. And that's particularly so given the weather in Washington these days. It's cold, slushy, wet, and gray in other words, a typical Washington winter. Of course you know that Washington, D.C., has four seasons: Fall; Sleet; Hay Fever; and Humid. Southern California, on the other hand, has only two seasons: beautiful and warm; and beautiful and somewhat less warm.
Being here at the del Coronado is also a great object lesson in the time value of investing. Back in my great grandfather's time, a piano maker, a retired railroad man, and their banker friend bought the entirety of Coronado and North Island for a mere $110,000.
And it didn't take long for the hotel they built here, mostly with Chinese immigrant labor, to become a global attraction. It wasn't just American celebrities that came here, such as Thomas Edison, L. Frank Baum, and Charles Lindbergh; even King Edward VIII reportedly met his future wife in this hotel. Wallis Simpson, of course, was a Coronado resident.
But beyond all of this history and the glorious weather, another reason I'm especially pleased to be here with you today is to talk about the challenges and opportunities we all face as our securities markets grow more integrated and more global every day.
As recently as the summer of 2005, when I made my rounds in the Senate before my confirmation hearings, there was very little focus on the integration of securities exchanges across borders, or the impact of the retailization of international investment, or the consequences of international cybercrime for securities law enforcement.
Today, on the other hand, the pace of events in the world's capital markets has placed global consolidation at the top of everyone's list of what is important for the future. Ever more public companies are raising capital beyond their geographic boundaries, and investors large and small are increasingly allocating their capital and their business assets outside their home countries.
Now, it's a fact that our capital markets and our trading markets have always been global. But it has been in just the last few years that the exponential advances in computer technology and telecommunications have all but eliminated the remaining physical barriers to market access. Today, almost any business, or any trader, can pick up a phone, or just press the "Enter" key on her computer, and effect significant transactions half a world away.
Of course, the pending combination of the New York Stock Exchange and Euronext, and Nasdaq's bid to acquire the London Stock Exchange, are also significant manifestations of this shrinking world. But these mark a beginning, not a conclusion. In the next few years, the world's capital markets will become even more integrated and in a very short span of time, the structure of the planet's exchanges and trading platforms will be completely rebuilt. Not only will U.S. exchanges seek to acquire foreign markets, but overseas exchanges will seek to acquire or combine with U.S. markets. In fact, this is beginning already.
This accelerating integration of our capital markets is not an unmixed blessing. But it holds potentially powerful benefits for America's investors. They'll have more choice than ever before. And their transaction costs will be driven lower by the combined forces of competition and technology. They'll have more, and better, opportunities to diversify their risk. And by participating in a truly global market that rations capital to its highest and best uses in a genuinely worldwide competition, their investments will be accelerating the pace of economic growth for everyone on the planet.
But in a world in which investors can easily choose where they want to trade, every national government will face new strains on its ability to impose and enforce securities regulations.
After all, if investors find the regulations of a particular jurisdiction to be either so onerous as to diminish returns, or so weak as to fail to protect property rights, it will be increasingly easy for them to simply take their money somewhere else. What's more, national regulations which don't work well in this new environment of global capital markets will actually work to harm investors by cutting off opportunities for investor choice, by raising trading costs, and by undercutting the effectiveness of securities law enforcement through a bunker mentality that ignores what's going on around us.
None of this means that national regulation is becoming irrelevant. On the contrary, if anything, national regulation will be even more important in the future than it was 30 years ago, when stock exchanges were entirely domestic affairs. That's because a globalized marketplace offers not only benefits to investors, but potentially significant risks as well. And those risks can threaten not only investors, but our entire economy.
The threat comes not from fear of foreign competition, or foreign issuers, or foreign investors. Both competition, and the influx of foreign capital and issuers, promise only good for our markets. Rather, the threat comes from the increasing opportunities for fraud, unethical trading practices, and market manipulation that globalization brings with it. Just as investors and issuers can more easily seek each other out around the world, those with less honorable intentions can also reach across borders, to prey upon distant investors. And when they succeed, they damage confidence in all of our markets.
It is the job of national regulators to wade into this fray to protect investors, and to promote the market integrity that capital formation depends upon. We really have no choice: after all, there's no global regulator who can do the job for us.
But in light of the continuing rapid evolution of technology and the globalization of markets, regulators need to constantly rethink our approach to cross-border financial services. From the standpoints of both market efficiency and stronger enforcement, we need to challenge long-held assumptions about how best to achieve our national regulatory aims.
As you all know, the scandals of the 1929 market crash led directly to the passage of the first federal securities laws in the 1930s, which, in turn, gave birth to the SEC. As it happens, around the very same time, France was building the Maginot Line to protect itself from invasion.
The plan was for a network of massive forts that would halt an invasion long enough for the French to mobilize their army, and then serve as a base to repel any attack. The confidence in this strategy among the best military thinkers of the day was so strong that they concluded the Maginot Line wouldn't just slow an attack, but would deter it completely, at least from that direction. As a result, Germany would be forced to invade, if it did so at all, from the north through dense forests, and across the territory of other countries that were allied to France.
The lesson of the great World War, after all, was that modern technology could make fixed defenses virtually impervious to assault.
You all know how this story ends, of course. History has a way of wreaking havoc on those who fail to anticipate the full meaning of future technology. As it happened, the technology that opened the Second World War was far superior to that which ended the first. And with the benefit of hindsight, historians have passed an unrelentingly hostile judgment on the Line.
But what is so fascinating about this well-known failure is that the Maginot Line actually worked precisely as it was intended. It really did deter the Germans from launching a direct invasion of France, and it forced them to march their armies instead through Belgium and the heavily forested Ardennes. But because technology had changed, the diverted invasion didn't take weeks, as was expected rather, Germany's new armored divisions rolled through these areas in just a few days. And the cutting-edge technology of radio-equipped Panzer tanks permitted the German Army to march not en masse, but in so many discrete, individual units, each able to operate independently under separate command in order to find and infiltrate weak spots in the enemy line.
So even as the Maginot Line stood, Paris surrendered.
This piece of history is a useful parable for securities regulators, about the importance of constant re-evaluation of our regulatory defenses in light of ever-improving technology.
Without a doubt, our regulatory defenses proved very effective in maintaining healthy markets in the 20th century. The world-beating success of America's capital markets is a testament to that. For most of the last 74 years, our ability to police our markets and maintain investor confidence in their integrity has been premised on requiring both domestic and foreign market participants that operate in the U.S. to register with the SEC and for the most part, to follow the same rules. That approach has followed from our concern that the alternative, permitting foreign market participants to operate in the U.S. without direct SEC oversight, would threaten the integrity of our nation's capital markets.
But while this approach served us well in the past, when the world's capital markets were separated not just by oceans but by the preference and habits of most investors, the world is a far different place today. And so we have to ask ourselves: have the basic assumptions on which we've built these regulations changed?
Fortunately, unlike the Maginot Line, our rules aren't static; they have evolved considerably over the last several decades. Indeed, one of the key success factors in our regulatory approach has always been matching our constancy when it comes to protecting US investors and the integrity of our markets, on the one hand, with a great deal of flexibility when it comes to finding ways to achieve these goals, on the other hand.
Still, in a world where capital and information can quickly race around any regulatory Maginot Line, or just scurry over it, we'd be well advised to constantly reconsider our regulatory defenses in light of the changing conditions.
That's especially true because it isn't just honest investors who will reap these new opportunities to move freely from country to country. Fraudsters and criminals are becoming increasingly sophisticated in the use of technology to help them find the weak spots in our financial infrastructure, and to exploit the seams in the regulatory defenses between nations. The same technology that is making distance irrelevant in supply chains and product markets is making it possible for wrongdoers anywhere in the world to play in whatever yard they wish, even though they may be physically located across an ocean or on the other side of the planet.
As these fraudsters network their wrongful activities from many different jurisdictions, they not only render enforcement that much more challenging, but they also make it less likely that any one nation will have the incentive, or the resources, to track them down.
Yet another way in which technology is making global securities crooks more difficult to hunt down is by allowing fraud to be "disaggregated." Just as a legitimate company might find it valuable to outsource certain activities so that they can concentrate on what they do best, those who commit fraud are increasingly outsourcing certain of their activities, such as collecting name lists of potential victims, or setting up offshore accounts that are hard to trace, or creating false office addresses. So an evidence trail that used to yield to detective work in one country may now span three, four, or even a dozen nations.
This newfound ease with which fraudsters can take advantage of our borderless capital markets threatens to turn our national systems of regulation into a shield for theft, rather than so many swords for detection and prosecution. Just as the bank robbers of old could thwart capture by heading for the county line, today's high tech securities swindlers intend to exploit the fact that regulators can't always engage in hot pursuit beyond their borders.
If this is what globalization of our capital markets really means if fraudsters can evade prosecution and punishment by hiding in cyberspace then all of the benefits of high-quality regulation that we have worked so hard to secure over the last three quarters of a century will simply be lost.
I'm convinced that the way to surmount these new challenges posed by technology is to harness the power of that same technology. We've got to recognize that to catch a global network of market crooks, it will take a global network of securities cops.
That means that our success will be measured not by the degree to which we close off other marketplaces from our own, but rather by the extent to which we more closely integrate our regulatory efforts as our markets themselves become more closely connected.
Every regulator has an obligation to the investors and issuers within its borders to protect them from fraud perpetrated within those borders. For the SEC, therefore, every other like-minded regulator is our natural ally. We've made great strides in recent years in building ways to share enforcement information with our counterparts in other countries, and to cooperate in doing every other part of our jobs. And as the story of this success has spread, we have found new friends and allies sharing the same concerns and devoted to the same cause of protecting investors and promoting capital formation.
This process of discovering our mutual interests has led us to realize that some of the old ways of doing things are obsolete. For example, while our historical justification for having issuers, broker-dealers and exchanges to register with the SEC is sound, it may be that by working with like-minded foreign counterparts we can find ways to lower costs and increase opportunities for investors while still maintaining the highest standards of investor protection. In this regard, the Memorandum of Understanding we recently concluded with the College of Euronext Regulators should be an excellent start.
And this brings us to an interesting question. Just what is "like-mindedness"? Will we know it when we see it? I believe the answer to this question is not wholly subjective. In my discussions with our counterpart regulators in other countries, I have found one touchstone in particular that is of overarching importance. It is an acceptance by the regulator that the genius of the market is that individuals are free to investigate their options and make their own decisions. It is an appreciation for the "wisdom of the crowd" that is ultimately the consensus of that market representing the solution of many minds working on a common problem.
Working with all of the world's regulators who share this belief in the power of markets, we can tap that same principle, so that a multiplicity of jurisdictions each seeking to develop the best regulatory framework can likewise investigate their options and make their own decisions about ways to handle regulatory issues within their borders. This is something from which we all can benefit: observing what works, and how the market responds, and learning from what doesn't work.
To give you just one example of what the "wisdom of the crowd" means for securities regulators, consider the global reaction to the Sarbanes-Oxley Act. There has been loud complaint about its costs, even by some in other jurisdictions to whom it does not apply. But one interesting effect of these reforms has been the degree to which they have been copied, in one form or another, in many other major markets.
Granted, the way specific provisions of Sarbanes-Oxley have been implemented abroad has varied. But even here, understanding the variations from country to country, and the reasons for those variations, has helped us. The SEC's recent management guidance regarding Section 404 of the Sarbanes-Oxley Act benefited greatly from what we observed in other jurisdictions that have implemented issuer internal control standards.
Another example of the wisdom of the "regulatory crowd" is the migration toward eXtensible Business Reporting Language, or interactive data.
As is clear to anyone involved in the financial services industry today, capital has no nationality. It speaks all languages. It seeks efficiency. But in order to realize its potential, capital must find its way to the persons and places where it will be used most efficiently. And that requires information, which in turn requires that markets are transparent, and that the information has integrity.
But despite its importance, transparency has proven surprisingly difficult to achieve, particularly across borders. Corporate governance, auditor oversight requirements, and regulatory approaches vary widely across jurisdictions. These variations reflect differences in culture, legal systems, and market structure. And there are those who believe that these differences pose intractable difficulties, so that despite our aspirations, markets will never be truly global.
Here again, however, rapidly advancing technology stands to upend the conventional wisdom by providing us with an unexpected way to deal with these differences. In the same way the experienced traveler uses a dictionary to navigate between languages in which the same thought is expressed in two different ways, interactive data can give us a way to translate between accounting languages in which the same set of data is presented in different ways. And so, perhaps, we'll one day reach a point where it doesn't matter whether a company's financials are stated using US GAAP, or International Financial Reporting Standards. In fact, it may turn out that each individual investor can decide that the data should speak a language uniquely his or her own.
As you know, interactive data is a whole new way for delivering the numbers and other information in financial statements. It gives users the ability to manipulate data, compare it, test it, and make it come to life. It's already showing us that it can make financial reporting faster, and less expensive for issuers. And it guarantees far greater accuracy in the numbers than today's system, with its multiple and redundant manual inputs. Most important of all, interactive data makes financial reporting more useful to investors who after all, rely on the data in making their investment decisions.
Nowhere is the trend to globalization of our markets and collaboration among international regulators more in evidence than with interactive data. At the same time the SEC is working with U.S companies to move to interactive data, other countries, including Japan, China, and the United Kingdom, are rapidly implementing this technology in their own securities, banking, tax reporting, and financial sectors.
It's impossible to overstate the potential of interactive data for the globalization of markets. Whether or not the nations of the world ever come to agree on every accounting convention or financial reporting rule, interactive data holds the power to reconcile our differences, quickly and efficiently, so that we can use the disclosures that government requires knowledgeably and meaningfully. And after all, that's the real purpose of securities regulation in the first place.
The imperative of rapid globalization has forced me to conduct my responsibilities as Chairman of the SEC far differently than my predecessors. In less than two years, I have met here in the United States and overseas with the finance ministers, central bankers, and securities regulators of the European Union, the Euronext College of Regulators, France, Austria, India, Japan, China, Korea, the United Kingdom, Canada, Australia, Portugal, the Netherlands, and Israel.
With the Euronext regulators, I have had sustained discussions, and full-day deep-think sessions, to get at the fundamental questions of what each of our nations is seeking to achieve, and how best to harmonize our approaches. With the UK, we have had multi-day off-campus planning sessions both in Washington and in London. And in the next few months I plan to do the same with Japan, with full-day conversations here in California, and then in Tokyo.
As each of us looks to cooperate with one another, the world's governments are quickly coming to see that there is no "one true path" to securities regulation at any one point in time. What we are seeking instead is an understanding that if a jurisdiction adopts an approach that adequately protects investors, that approach is worthy of respect.
So allow me, at this point, to advance a proposal.
The way for the United States to maintain robust investor protections while building healthy international markets is first, to ensure that our regulatory regime at home is both sturdy enough to withstand the onslaught of today's new technologies and the challenges of high volume cross border trading; second, to ensure that our regulations are in every respect cost-justified; and third, to cooperate with our fellow securities regulators abroad to implement agreed-upon regulatory objectives on a global level.
Adopting this way forward means we and every one of our fellow regulators have 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.
Securities 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 gatherings with practitioners and businesses and investors. 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.