Speech by SEC Chairman:
Address to the American Academy in Berlin and the American Chamber of Commerce in Germany
Chairman Christopher Cox
U.S. Securities and Exchange Commission
Hans Arnhold Center
April 26, 2007
Thank you, Jochen [Sanio, President of BaFin] for your kind introduction -- and to Mr. Irwin [Frederick Irwin, President of the American Chamber of Commerce in Germany], Dr. Smith [Gary Smith, Executive Director of the American Academy in Berlin], and all of you who have made it a point to be here tonight, thank you for your commitment to the broad and sturdy partnership between Germany and America that we're celebrating here this evening.
It is especially poignant to be meeting with you here at the Hans Arnhold Center. The history of this location is a testament to the resilience and optimism not only of Berlin, but of Germany and all of Europe as well. Hans Arnhold, of course, is known in the United States as one of the founders of the financial firm Arnhold and S. Bleichroeder. But here in Berlin you all know that what is now the Hans Arnhold Center was his family's home, until he was forced to flee when the National Socialists came to power. After the war, the city of Berlin used this villa as a refuge for German families and individuals fleeing Communism in the East. And it is now the home of the American Academy in Berlin, to which I wish to express my deep gratitude for your co-sponsorship of tonight's event. The Academy, and this place, are symbols of the friendship and shared scholarship between our two countries.
With its history and its beauty (and this sunny evening on the lake is as beautiful as can be), this Center is a perfect ambassador for Berlin itself. And Berlin is very much the perfect ambassador for the European Union. Despite the trauma of its history, Berlin has risen from war and partition to lead the East and the West in unification and prosperity.
The objectives of unification and prosperity are of course the great experiment of the European Union as well. Uniting the nations of Europe in peace and prosperity is an undertaking as ambitious as it is important to the entire world. But even beyond the unification of Europe, our global markets are leading the way to a transatlantic cooperation that itself is just as important to building bridges and understanding, and ultimately to promoting peace and prosperity. And just as with the unification of Germany and the creation of a united Europe, the way forward for our capital markets requires not only hope but also patience, thought, and wise choices. As the world's markets continue to grow and integrate, Germans, Europeans, Americans, and the entire world stand ready to reap the benefits.
At the same time, as our markets become increasingly interconnected, the regulatory friction from different national regimes becomes more significant. That is challenging regulators to think about what we can do, individually and together, to help realize the benefits of a global marketplace. And it is requiring us to think carefully about the consequences of globalization for our fundamental missions of investor protection, capital formation, and the maintenance of orderly markets.
One of Germany's greatest thinkers once said, "I hate all bungling like sin -- but most of all bungling in state affairs; that produces nothing but mischief for thousands and millions." There are always serious consequences when government policymakers get it wrong. So while it is true there are remarkable opportunities ahead of us, in embracing those opportunities we've got to keep our principles sharply in focus. I can assure all of you here this evening that the thousands of men and women at the Securities and Exchange Commission are doing just that.
Our deep commitment to investor protection and to an increasingly closer cooperation with our counterpart regulators is reflected in the document I signed today with President Sanio and the BaFin. Both Germany and the United States have committed ourselves to a process that will insure far deeper and closer consultation, cooperation, and exchanges of information about regulated entities and financial groups that operate in both countries. We have also outlined a framework for cooperation in the oversight of markets in both countries. We were able to do this because both the SEC and the BaFin share a commitment to keeping our markets open and fair. We recognize that by sharing information and granting one another access to our own regulatory data, we can both do a better job of supervising global securities firms and overseeing what are now truly global markets.
Today, when investors look across the Atlantic, it is possible to see bonds between our markets that are stronger than ever before in history. The combined NYSE and Euronext comprise a transatlantic company that operates six different exchanges catering to many different types of issuers. The International Accounting Standards Board and the U.S. Financial Accounting Standards Board have for years been working on a convergence project to eliminate needless regulatory friction between International Financial Reporting Standards and U.S. Generally Accepted Accounting Principles. And that has made possible the SEC's announcement this week that we are taking the next steps on our Roadmap to eliminate the reconciliation requirement in the United States.
In the brief moments we're sharing tonight, I'd like to share with you just a few thoughts on that issue, as well as the related question of mutual recognition. And as I do so, it is important to make one basic point as a foundation for those topics.
As regulators, we have to be aggressive in our role as market referees and protectors of investors' interests. And at the same time we have to be humble in recognizing that regulation is not the fuel that drives our markets - though it undoubtedly is the oil that greases the gears. Too little regulation, and investors demand a premium for their money to compensate them for the greater risks they face in a lawless market. Too much regulation, and the costs outweigh the benefits - robbing investors of return and making markets less efficient. When that happens, not just investors but consumers and entire national economies pay. So it is always important that regulators strike a balance between under-regulation, which carries with it the risk of fraud, abuse, and a loss of investor confidence, and over-regulation, which saps the economic vitality of otherwise vibrant markets.
What isn't so obvious is that this balance can be achieved in different ways. The differences in national systems of regulation aren't necessarily reflective of regulatory competition, or worse yet, intentional regulatory arbitrage by governments. Different markets can legitimately have different concerns. And those concerns arise, in many cases, from unique circumstances.
One of America's early icons was a rough-and-tumble frontier lawyer who was also Tennessee's first Congressman. He once memorably said, "It is a damn poor mind indeed that cannot think of at least two ways to spell the same word." Old Hickory, as he came to be known, was our nation's seventh President. Andy Jackson's folk wisdom is a good reminder to us today as we tackle the question of when it is better to be the same, and when it is better to be different.
The European Union itself is a vivid demonstration of why differences in markets can sometimes justify differences in regulation. In the United Kingdom and the Netherlands, for example, ownership of most public companies is widely diffused. There are few, if any, shareholders that own a controlling block of a public company's shares. In Germany, many public companies have controlling shareholders. Traditionally, those have been large banks. In Italy, the controlling shareholders are often entrepreneurial families. Even in markets that seem similar, we often see differences that profoundly affect how our markets work. For example, like the United States, the United Kingdom has many companies owned by large numbers of shareholders, none of whom owns enough to constitute control. But unlike the United States, the UK market historically has not had a very large retail component. Over the past few decades, the investors that predominate are not retail investors but large financial institutions, all located within a few blocks of each other in the City of London.
There are historical reasons for all of these differences, of course, and regulators need to take them into account. And the important point is this: when it comes to securities regulation, differences in market structure will necessarily give rise to different problems, and it is up to the national regulator to diagnose and treat them.
For example, in markets with large blockholders, or markets where retail investment isn't common, regulators will naturally focus first on protecting minority shareholders from possible abuses by controlling shareholders. In other respects, they're more likely to take a "caveat emptor" approach to oversight. On the other hand, in markets with diffuse share ownership and heavy retail participation, regulators tend to focus on areas such as auditing standards and internal controls, to help these shareholders guard their interests against possible managerial abuses.
I'm absolutely certain that we can accommodate these differences as we seek to increase regulatory cooperation around the world. But unless we keep in mind the reasons that legitimate differences can exist - and it's easy for us to forget that, in our increasingly globalized world - then the job of mutual cooperation will be made needlessly more difficult. Just because capital now flows across borders more easily, and businesses routinely operate on a worldwide basis, doesn't mean that a one-size-fits-all approach to securities regulation is wise. We've got to respect our differences as we build on common ground.
Having said that, recognizing that there are differences doesn't require us to give up on the idea that convergence can be achieved in many important areas, or on the idea that mutual recognition is possible after a significant degree of convergence has been achieved. But it does mean that we regulators have to look closely at our national systems. We have to ask ourselves exactly why we do what we do. And if the answer is because we've always done it that way, that won't be enough.
Any regulator that engages in a serious and critical self examination will undoubtedly conclude that some of its regulations that differ from those in other countries are necessary because they are tailored to the markets in that particular jurisdiction, and they address very real problems. And that same regulator would also likely find that some of its regulations are the result of legislative mandates that simply can't be changed by the regulator. But it might also discover that some of its regulations are simply redundant, or are merely the remnants of problems that have long since been resolved. When this is the case, it behooves us all to eliminate the redundant rules, and the legacies that have ceased to serve their original purposes.
And when the regulator finds that its rules are different from other jurisdictions, but that the way others have chosen to solve the same problem is a difference in form rather than substance, then conforming the rule to what counterpart regulators are doing will achieve all of the benefits of the current regulation while reducing costs for the benefit of investors and businesses alike.
As our markets evolve and globalize, we find that we now have more things in common than we used to. The need to get help from our neighbors when we deal with cross border fraud in the Internet age has nearly driven us into one another's arms. We all understand that we can't go it alone, if ever we could before. And as the SEC works with our counterparts overseas, we're increasingly finding that in many areas our regulatory objectives are very much the same.
In fact, we've now reached the point where we can ask: Given that our regulatory objectives are the same, shouldn't our regulations be the same as well? That we can ask the question at all is a testament to just how closely our markets are linked, and a tribute to the efforts that regulators around the world have made in seeking common ground. But let me anticipate the analysis and go straight to the answer to that question:
No. Our regulations shouldn't all be the same.
There is fool's gold here - the notion that a universal, global, single set of regulations would allow businesses, financial firms, and investors to operate in a completely borderless world. However attractive that utopian vision might sound to some, we must never forget that our rapidly globalizing markets present not only splendid new opportunities, but serious new dangers of fraud and unfair dealing.
And here is the risk in meeting the globalization of markets with a plan to merge all the world's securities regulatory regimes into one: Even where our regulatory objectives are the same, regulators are not omniscient. We don't always have the right answers to the problems that lie before us.
Experiments are as valuable to the regulator as they are to the scientist. While it's easy to imagine that conformity with a single standard has many advantages - and indeed, sometimes it does, since in many cases the comparability and simplicity of having just one approach outweighs the benefits that accrue from regulatory experimentation - that is not always the case. As a result, we regulators have to become comfortable diagnosing the differences.
We should also be comfortable with giving investors choices. The idea that informed investors are in the best position to judge for themselves how to allocate their capital is the bedrock upon which America's securities laws are built. That's why ensuring that both retail and institutional investors are properly informed is so central to the SEC's investor protection mission.
So our task is to secure the many potential benefits of global markets for investors and issuers alike, while continuing to provide the strong investor protections that our capital markets ultimately depend upon. We've got to be confident in determining that in some cases, convergence and harmonization are the right approach; that in other cases, an intentionally different national approach is best; and sometimes, simply offering investors a choice after full disclosure is the way to go.
Let's consider a concrete example: the move that's afoot here in Germany, throughout Europe, and around the world for a truly global set of high quality accounting standards. The vision behind International Financial Reporting Standards is that a single worldwide set of standards will permit investors around the world to benefit from a high level of comparability and a consistently high level of quality in financial reporting. It would eliminate the need for investors and analysts to try to understand financial statements that are prepared using the different accounting standards of many jurisdictions. And it would eliminate one of the significant barriers to raising capital outside one's borders.
IFRS promises to integrate our markets. But that promise is jeopardized if IFRS isn't applied faithfully and consistently across jurisdictions. Regulators must beware the impulse to develop nationally-tailored versions of IFRS, and we must cooperate with one another in implementing a set of standards that is faithfully and consistently applied.
Since 2005, the SEC has been following a publicly announced "Roadmap" that charts a path to when issuers would no longer be required to reconcile their IFRS financials statements to U.S. GAAP. We have traveled far along that road. The SEC has already been gaining insights into how IFRS works in practice, by reviewing the filings we've received from those foreign private issuers that adopted IFRS in 2005. Meanwhile, our staff are cooperating with the Committee of European Securities Regulators under a joint work plan that we announced just last summer. We also recently hosted a Roundtable on these topics, and the feedback was extremely positive. We're well down the path charted in the "Roadmap," and we're still very much on track to eliminating the reconciliation requirement by 2009, if not earlier.
The SEC has also been mindful of the other ways in which U.S. laws and regulations affect foreign issuers in our markets. In particular, we have noted the concerns raised by foreign private issuers about the application of Section 404 of the Sarbanes-Oxley Act. We have twice extended the compliance deadline for certain foreign private issuers. We've been sensitive to the particular needs of foreign private issuers, and we have worked to minimize the burdens that 404 may impose on them.
I also want to point out that the new deregistration rule takes effect early this summer, allowing foreign private issuers that have a relatively small U.S. trading volume to withdraw their registration and end their U.S. reporting obligations. In short, foreign private issuers can withdraw rather than comply with 404, if they so desire.
But because the concerns raised by foreign private issuers about Section 404 weren't unique to them, the Commission has formally proposed new guidance to assist management in evaluating their internal controls over financial reporting. At the same time, we are working closely with the Public Company Accounting Oversight Board to completely replace the existing auditing standard under 404 with a much shorter, risk-based and principles-based approach that will make compliance more rational and efficient, while at the same time better focusing the internal control assessment and auditing effort on what is truly material to the integrity of the financial statements. That work, we expect, should be nearly completed by the end of next month, in time for companies' 2007 annual financial statement preparation.
Of course, our work on more closely integrating our regulatory structures isn't limited to accounting standards or Sarbanes-Oxley. Lately, we have even begun to talk about the possibility of a world in which non-U.S. broker-dealers and exchanges could apply for exemptions from SEC registration. I think that we're now beginning to realize that some of the old ways of doing things may have grown obsolete. While our historical justification for requiring foreign broker-dealers and exchanges to register with the SEC is sound, it may be that by beginning a dialogue with our foreign counterparts, we can find ways to lower costs and increase opportunities for investors, while still maintaining the highest standards of investor protection. In an effort to facilitate that dialogue, I have called upon SEC staff to set up a roundtable that will take place this summer, where we can begin to discuss these important issues in earnest. This dialogue is an important one, because as regulators, we owe it to those whose interests we protect to do what we can to bring our markets into the 21st Century.
The challenges we face are daunting, but I am absolutely certain that by working together, we can build a regulatory framework that supports global markets. After all, working together, our countries have confronted and surmounted challenges far greater than these in the past.
If you seek an example, you need look no further than this very city. As many of you know, in May of 1955, the Federal Republic of Germany joined the North Atlantic Treaty Organization. Halvard Lange, at the time Norway's foreign minister, described it as "a decisive turning point in the history of our continent." NATO withstood the Soviet threat against which it was created - and NATO continues today as a force for peace, because it is an alliance of like-minded nations with a common objective.
Many of us, as securities regulators, are similarly like-minded and we share common regulatory objectives. Even where our particular tactics differ, we must see ourselves as allies in a united effort to improve our markets together, for the benefit of our investors.
Not all of the world's securities regulators share the same objectives, of course. That, too, is often times a good thing. Not all of our markets are the same, either. But where we do share the same objectives, we should seek to make common ground. Where possible, we should work closely together to eliminate unnecessary and redundant regulations, to recognize how different regulatory approaches may achieve our shared objectives, and to learn from each other about what works and what doesn't.
And we should learn together to trust the choices investors make as we help ensure that those choices are fully informed.
I know everyone in this room is committed to these objectives. Thank you for inviting me to participate in this important discussion - and most of all, thank you for what each of you does every day to bring our nations and our world closer together.