Speech by SEC Commissioner:
Remarks Before the Governance for Owners Conference
Commissioner Roel C. Campos
U.S. Securities and Exchange Commission
March 22, 2007
Good morning. To start, I'd like to thank Robin Hindle Fisher for his kind invitation to join you here. Hopefully, I can hold my own in the "debate-style" nature of today's talk. In an effort to manage expectations, I should note that I'm at a distinct disadvantage here because this sort of back and forth is not the norm in the United States. We're used to the endless speechifying of the U.S. Congress, which is much more sedate than the boisterous debate of Parliament. But I'll do my best. In any event, before I begin, I must remind you that the comments I make today are my own and do not reflect the opinions of the staff or the other Commissioners of the Securities and Exchange Commission.
II. Proxy Access.
At the outset, I find it extremely ironic that I'm supposed to defend the lack of shareholder proxy access in the United States. As many of you may know, I've been the strongest advocate for increasing shareholder proxy access in the U.S. ever since the SEC proposed rules in this regard back in 2003. Unfortunately, however, we were never able to finalize those rules.
To be quite blunt, the U.S. is on wrong side of the tracks on this issue. And the U.S. system of electing directors is an absolute joke. Shareholders in the U.S. - even very large, institutional shareholders - have virtually no meaningful choice with respect to the election of directors. In the U.S., directors are elected by a plurality vote, which means that those directors receiving the most votes are elected to the board, even if those directors do not receive a majority of the votes cast. Quite literally, a director could get elected to the board with a single vote. Now, this is changing because companies are adopting majority voting requirements, but these are often voluntary. Further, these majority voting rules do not permit shareholders to affirmatively nominate a director. Rather, they merely make it easier to vote off directors. In any event, I'll concede that the lack of proxy access in the U.S. is a distinct negative.
That said, talk is cheap and debate is easy. The real value of conferences like this is not merely to argue about which system is best or whose laws are better. Rather, the goal of the debate should be to effect meaningful change. To that end, I've literally done all I can to establish proxy access in the U.S., and I've supported it at every turn. When the issue came before a U.S. court last year, I insisted that the SEC not formally submit a brief that supported the status quo. And, I was successful in this regard, for the court ruled in favor of shareholders and allowed them access to a corporation's proxy. Now, the ball is back in the SEC's court, and we have been discussing what to do internally. Given that we haven't done anything yet, I think you can assume that we haven't reached consensus.
But that's where you come in. As I said, it's not enough to win the argument that having proxy access is a good thing. We must effect meaningful change. To that extent, I urge all of you to write letters to the SEC, industry groups and corporations in the U.S., urging them to back proxy access. Tell them that it's in their economic best interest to do so, because it might lead to additional investment by European investors such as yourselves. We're at a critical point in the U.S. for proxy access, and you can make a real difference.
III. Advantages of the U.S. Market.
Well, I've conceded that one aspect of the U.S. governance system needs work. However, I will definitely not concede that the U.S. market is unattractive to investors, even foreign investors. Further, if foreign investors are significantly reducing their investments in the U.S. due to corporate governance concerns, I think they're making a mistake. Here's why:
In my role as the designated representative of the SEC in the international community and through my study of international matters, I've given significant thought to the U.S. regulatory system as compared to those of other markets. In short, I have become convinced that the U.S. regulatory system is, in fact, a "competitive advantage" for our markets. It's not nearly perfect of course, but nothing is.
Further, I find it curious that an investor would shun the U.S. market over a single issue, even one as important as proxy access. For example, many in Europe have been touting their so-called "light-touch" regulation as a means of promoting markets. Well, I suppose I can see how this might tempt certain officers or directors to list their securities in those markets, but it seems very odd that investors would find this to be a positive.
There's another general point worth noting. I know that past results are not a measure of future performance, but the relevant U.S. market indices have done very well as compared to some of the European indices. Of course, maybe it's time to sell high and buy low.
A. Section 404 of the Sarbanes-Oxley Act.
But back to my main point. That is, capital demands protection. Nowhere in the world is capital better protected than in the United States. I am told every day by major foreign investors that they invest billions of dollars in the U.S. because they love Sarbanes-Oxley. It is a truism that, if capital is attracted to the U.S., I can assure you listings and issuers will be close behind.
The most famous - or infamous - corporate governance rule in the U.S. is Section 404 of the Sarbanes-Oxley Act. Investors love it. Companies, perhaps not so much. In my opinion, SOX 404 provides great advantages and protections for capital, and the SEC and the PCAOB have been working non-stop to make its implementation better.
But the SOX 404 bottom line has not and will not change: SOX 404 is the only standard in the world where both the management of the issuer certifies the effectiveness of, and the auditor tests and attests to, internal controls. Moreover, the standards imposed by Sarbanes-Oxley are being emulated across the world in a local way, which I think is real world evidence that this is an important law.
One of the great strengths of the U.S. market is the system of high standards and protections of capital. This system will continue to attract capital from all corners of the world. I submit that investors appreciate and desire this high level of protection for capital. Indeed, the available data indicates that savings in the cost of capital for companies cross-listed on the U.S. are several times greater than the costs of complying with U.S. regulations. Specifically, because of the structural protections available to shareholders of U.S. companies, investors have a greater degree of confidence in U.S. companies. Moreover, a recent study notes that there is an overall premium averaging 30% for companies who cross-list in the U.S.
B. Minority Rights.
It's not just Sarbanes-Oxley. Another strength of the U.S. markets is our robust protection for minority shareholder rights, at both the federal and state levels.
The different states have responsibility for many of our corporate laws, and they have enacted numerous provisions protecting small shareholders from abusive actions of large shareholders and management. For example, under Delaware law: (1) any stockholder can inspect and copy a corporation's stock ledger, a list of stockholders, and certain books and records of the corporation; (2) any stockholder can sue for an appraisal by the chancery court of the fair value of the stockholder's stock in connection with certain mergers; and (3) interested director transactions are subject to heightened approval requirements.
Further, the U.S. federal securities laws and the SEC's rules also contain provisions aimed at protecting individual shareholders, such as: (1) requiring heightened disclosure for going private transactions; (2) requiring issuers to send proxy materials to all shareholders (not just certain shareholders); and (3) mandating significant disclosures for related-party transactions.
It's interesting that the U.S. corporate law has such protections for minority shareholders. This is especially true because most recognize that there is more dispersed ownership in the U.S., as compared to more concentrated majority ownership and more controlling shareholders in Europe. Of course, this is a broad generalization, but I think this dispersed ownership structure - coupled with rigorous protection of minority rights - would be attractive to European investors.
Obviously, the lack of proxy access makes it difficult for investors to have a direct say in electing directors, particularly when compared the fact that a 5% shareholder can put up a slate of directors in the U.K. But that said, how much influence will a 5% shareholder have over the directors and management of a company that has a controlling shareholder?
C. Principles-Based Regulation.
I should also touch on the concept of principles-based regulation vs. rules-based regulation. Let me make two general points here. First, I think the dichotomy between the U.S. rules-based approach and the U.K. principles-based approach is overblown. The U.S. has plenty of principles, and the U.K. has plenty of rules. Second, to the extent that the U.S. has more rules or less principles than the U.K., I think this is driven largely by the underlying nature of litigation in the U.S., rather that any particular regulatory philosophy espoused by the SEC or FSA.
1. Not Such a Difference After All.
As to my first point, I recommend that you read Callum McCarthy's excellent speech dated February 13, 2007. In it, he notes the following:
But the FSA is also an organization with a very large rule book (8,500 pages of rules and guidance), and could equally - or equally misleadingly - be described as a rule bound regulator. The reality is - and always will be - that the FSA has and will always have a mixture of general principles and particular rules.1
Well, I think the same thing could be said of the United States. And frankly, I'm pretty sure we don't have close to 8,500 pages of rules, although I haven't actually counted them. Let me be clear: I absolutely do not think that principles-based regulation is a bad thing. I would argue that we in the U.S. view ourselves as principles-based, but we also have specific rules as well.
For example, a lot has been made of the implementation of SOX 404. Much of the criticism has focused on the fact that companies have tried to comply with a one-size-fits-all requirement when the companies themselves vary tremendously in complexity and size. The SEC's proposed management guidance contemplates these differences and successfully accommodates them by providing a logical principles and judgment-based regime to evaluating the effectiveness of internal controls. It provides an approach for evaluating the effectiveness of a company's internal controls over financial reporting that is not prescriptive, but rather based around two broad principles - design and operating effectiveness.
As another example, take even our famous anti-fraud statute: Section 10(b) of the Exchange Act. I suppose in one sense it's a rule, but in another sense it's a principles-based statement that generally says that it is unlawful to use or employ a "manipulative or deceptive device . . . in contravention of" the SEC's rules. Plus, it's only 109 words long. (I actually didn't count this either, but one of my counsels did.)
To be fair, the SEC did publish a rule describing unlawful conduct under Section 10(b): namely, the even more famous Rule 10b-5. Now, I certainly can't argue that this isn't a rule, given that that we explicitly call it a rule. But again, it contains three broad principles. It says: (1) you can't employ any device, scheme or artifice to defraud; (2) you can't make any untrue statement of a material fact or to omit to state a material fact; and (3) you can't engage in any act, practice, or course of business that operates as a fraud or deceit upon any person. It's 118 words long.
Now, I don't have exact statistics for you, but I would guess that a majority of the SEC's Enforcement cases are based primarily on these 227 words. Not bad for an allegedly rules-based regime.
2. Underlying Realities.
Now to my second point. Even if we assume that the U.S. system is more rules-based than is the U.K., there are reasons for it. And arguments about which is better - rules-based or principles-based - miss the point because it is far more relevant to understand why the two systems differ. To put it another way, there are good reasons why the U.S. is more rules-based and the U.K. more principles-based. And to argue that one country or the other should adopt a different system ignores the realities at hand.
To be specific, the U.S. securities market has a much larger retail and individual investor component to it, while the U.K. is more dominated by institutional and controlling shareholders. Given this, it seems obvious that there should be different approaches to regulation. In the U.S., we need more specific rules and regulations that apply with clarity so that the less sophisticated individual investors can understand them. By contrast, in the U.K., the large institutions are better able to cope with more general principles. I invite you to take a look at a recent speech given by the SEC's Director of the Office of International Affairs for more detail on this.2
In addition, the level of litigation in the U.S. - particularly, private litigation not involving the SEC or any government entity - far outstrips that of the U.K. Given this, it's not surprising that there are specific rules and regulations. Individuals, companies and regulated entities want to know what's permissible and what's not so they can tailor their conduct accordingly. The rules in many instances provide a safe harbor from litigation.
These differences are why it's an academic exercise to argue about whether principles-based or rules-based regulations are better. The underlying market realities drive the differences, and unless we address the structural differences, it doesn't make sense to adopt an inconsistent regulatory theory.
My time is short here. I could go on and on about the many ways in which the U.S. corporate governance structure protects investors - many of which have been adopted by other jurisdictions. But I don't want to take away from the discussion and questions. My bottom line is that the U.S. system provides for incredible investment opportunities. While there are certainly further steps that can be taken to empower shareholders, our protection of capital is unparalleled and our investment opportunities are extremely diverse. Thank you.